DBRS Comments on Fortis Inc.’s Announcement of the Acquisition of the Waneta Dam

DBRS Limited (DBRS) has today commented on Fortis Inc.’s (Fortis or the Company) announcement that it has entered into an agreement to acquire Teck Resources Limited’s (Teck) two-thirds interest in the Waneta Dam and related transmission assets in British Columbia (BC) for approximately $1.2 billion in cash (the Acquisition). DBRS expects that the Acquisition would not have a material impact on the Company’s current credit profile. On May 3, 2017, DBRS confirmed Fortis’ Issuer Rating and the rating of its Unsecured Debentures at BBB (high), and the rating of its Preferred Shares at Pfd-3 (high), all with Stable trends. DBRS’s confirmations reflected Fortis’ solid financial performance in 2016 and Q1 2017 and its stable business risk profile since the closing of the ITC acquisition in October 2016 (see DBRS report on May 9, 2017, for more details).

THE ACQUISITION
The Waneta Dam, located on the Pend d’Oreille River, has a total capacity of 496 megawatts (MW) of renewable power and generates an average of 2,750 gigawatt hours of energy per year. Under the agreement between Fortis and Teck, Teck Metals Ltd. (owned by Teck) will be granted a 20-year lease to use Fortis' two-thirds interest in Waneta to produce power for its industrial operations in Trail, BC. Annual payments will begin at approximately $75 million per year and escalate at 2% per annum, equivalent to an initial power price of $40/MWh based on 1,880 gigawatt hours of energy per annum. Teck Metals Ltd. will have an option to extend the agreement for a further ten years at comparable rates (the Power Agreement). The Acquisition includes the Line 71 transmission line and other local transmission assets. FortisBC Inc. (FortisBC; rated A (low) with a Stable trend by DBRS), 100% owned by Fortis, currently operates and maintains Waneta Dam.

The Waneta Dam is governed by the Canal Plant Agreement (CPA), a contractual arrangement between BC Hydro, FortisBC and other plant owners along the Kootenay and Pend d’Oreille rivers. The CPA enables the parties, through the coordinated use of water flows and coordinated operation of storage reservoirs and generating plants, to generate more power collectively from their respective generating plants than if they were to operate independently, as such, mitigating hydrology risk for the Waneta Dam.

FINANCING
With respect to the financing of the Acquisition, Fortis intends to finance the Acquisition through a combination of cash on hand, debt and equity. DBRS expects that the financing of the Acquisition will be consistent with the Company’s existing capital structure and consistent with the level required by DBRS to support the current rating.

DBRS is of an opinion that the Acquisition will not have any material impact on Fortis’ Business Risk Assessment factors because of the small size of the Acquisition relative to the size of its assets. At the end of March 2017, Fortis’ consolidated assets were approximately $48 billion. The Acquisition would account for only approximately 2.4% of post-Acquisition consolidated assets. Post-Acquisition, total non-regulated assets would increase by 3% to 6% (approximately 3% at March 31, 2017). However, DBRS notes that the counterparty of the Waneta Dam generation for Fortis’ portion has a weak credit profile. DBRS currently rates Teck at BB (high) with a Negative trend. Fortis’ counterparty risk is mitigated by the fact that Fortis could sell the capacity to FortisBC, BC Hydro or the wholesale market in the event of default by Teck.

With respect to the potential impact of the Acquisition on Fortis’ financial risk profile, DBRS has reviewed Fortis’ financing plan and performed a pro forma analysis and is of the view that the Acquisition would have a minimal impact on Fortis’ consolidated financial ratios and would modestly weaken Fortis’ credit metrics. Assuming the Acquisition occurred on January 1, 2017, the pro forma non-consolidated credit metrics for 2017 are as follows: (1) cash flow-to-debt would decrease to approximately 14% (with the Acquisition) compared with approximately 15% (without the Acquisition) and (2) non-consolidated debt-to-capital would increase to approximately 27.5% (with the Acquisition) compared with approximately 25.5% (without the Acquisition). At these levels, the post-Acquisition non-consolidated credit metrics would still be supportive of the BBB (high) rating. DBRS expects Fortis’ credit metrics to improve over the medium term as a number of capital projects at its U.S.-regulated subsidiaries and Canadian-regulated subsidiaries are expected to be completed in 2017.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The principal methodologies are Rating Companies in the Regulated Electric, Natural Gas and Water Utilities Industry, DBRS Criteria: Rating Corporate Holding Companies and Their Subsidiaries and DBRS Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers, which can be found on dbrs.com under Methodologies.

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